It’s a big theme, sparking big debate. Stephen Dover discusses what current conditions mean for the economic concept to which we’ve grown so accustomed. As importantly, he highlights the implications for companies and investors alike. One thing is clear, it’s not an all-or-nothing situation. See his answers for insights on what’s driving change and factors that will influence the way forward.

Q: What’ s your sense of the current environment for globalization?

Stephen Dover: We’ve lived in an extraordinary time over the last 40 years with the Iron Curtain falling and China emerging. We’ve experienced the opening of half the world and, with that, a huge opportunity for trade and growth. Given the span of time, it’s not surprising to see globalization evolving.

Three forces have been underpinning this theme. First, the ability to shorten distances in both transport and communication, largely shaped by technological innovation. Second, nations have been willing participants in globalization, working within agreed upon frameworks for legal, security, business and financial engagement. Third, there have been incentives for companies and consumers to push the boundaries of what’s possible. For example, through international trade and supply chains, businesses have reduced production costs, increased profits and consumers have benefited from access to more at lower prices. It’s worth noting that talking about trade today involves not just goods, but services too.

The workings of today’s world are testing these fundamentals. The COVID-19 pandemic, for instance, revealed supply chain vulnerabilities and choke points worldwide. Companies are revisiting the just-in-time inventory management model that served them well over the last four decades and are looking at a just-in-case approach, where they bolster access to raw materials and products, having them always at the ready. This can involve ensuring resource supplies and manufacturing capabilities are in “friendly” countries, and/or moving capabilities closer to, or home. It's designed to help address supply and security concerns. The latter has emerged along with geopolitical tensions such as Russia’s invasion of Ukraine and the strategic use of trade as a foreign policy tool, particularly between the United States and China. The idealistic view that globalization would reduce military friction among countries has not turned out to be completely true, particularly in terms of technology and its central role in a nation’s security and military strength. We have seen companies such as Google in China and Huawei in the United States used as strategic proxies and expect this activity to continue.

On another front, China, known for many years as the “workshop of the world,” is now a middle-income country and its comparative advantage in supplying the globe with cheap manufactured goods has declined. For instance, labour costs in Mexico aren’t dramatically different from those in today’s China. While countries such as Vietnam and Bangladesh are benefiting from this reality, as of yet, no other country has stepped in as the new low-cost producer on a scale comparable to China.

Q: With such factors in mind, what’s the impact on globalization?

Stephen Dover: First, globalization is down but not out. The era of supercharged cross-border growth in trade and capital flows is over. However, we’re not seeing a generalized decline in international economic activity. For example, despite all the talk of reshoring to the United States and Europe, China’s exports boomed as demand for goods surged during the economic reopening of 2021 and early 2022,¹ revealing that global supply chains remain intact and integral to the world economy. Rather, the rate of growth has slowed and trade relationships and supply chain patterns are evolving as companies work to navigate business and geopolitical realities. 

Q: What are the implications for companies?

Stephen Dover: We’re seeing companies review their business models with three things in mind. First, where and how they sell products. Second, where they source materials and produce goods, prioritizing stability for both…certainly the cheapest option is now not the only consideration. Third, they’re focusing on decarbonization and their business’s environmental impact. Consumers and investors are increasingly concerned about what stands behind the goods or services they’re purchasing or the assets they hold. Social factors that focus on the fair and respectful treatment of all stakeholders in a business are top of mind for consumers. They’re looking for more transparency about the production process and its sustainability. We believe the decarbonization and deglobalization themes are interlinked.

Q: How will current conditions affect capital spending?

Stephen Dover: We expect slowing globalization will likely harm business investment spending and growth. Despite commentary to the contrary, globalization in the postwar era made economies more efficient and more productive. Trade is a positive sum. Now, as companies trim supply chains, the impact on global economic activity is negative.

Secular stagnation—defined as a prolonged period of chronic underinvestment in productive enterprises (investment in plant, equipment and new technologies) compared to the amount of savings in the economy—is increasing. It leads to a lower-trend growth rate as the “supply side” grows more slowly and to a demand deficiency as excess savings imply a spending shortfall in the economy. As a result, the economy tends to produce underemployment, low inflation, and very low real and nominal interest rates.

Although many central banks continue to hike interest rates to lower inflation, they can’t completely ignore the implications of very low long-run equilibrium interest rates. It’s necessary to slow demand and curb spiking inflation today, but overdoing things could be very damaging.

Q: What does this mean for corporate profits?

Stephen Dover: Using the United States as the test, we believe various factors suggest a golden era of rising profitability may be coming to an end. Cyclically, profits are at risk from a near-term slowdown or recession. Fragmenting global markets and falling participation rates may boost labour’s bargaining power. Rising borrowing costs and budgetary pressures make it less likely that profit growth can be sustained through interest and tax expense.

Two factors may play a big role in what happens to profitability. The first is whether governments worldwide will more closely scrutinize and potentially roll back the market power of dominant firms in concentrated industries.  Second, we live in times of unprecedented innovation yet output per hour of work is growing at paltry rates. If productivity growth accelerates, then a growing pie could accommodate larger slices for both labour and capital.

Q: How will deglobalization affect bottom-up stock selection?

Stephen Dover: We think analysts and portfolio managers will focus more on single countries rather than combined groupings, with the disaggregation of markets becoming a more important theme going forward. For example, innovation-led sectors within technology and health care are already a significant part of developed markets. They’re also becoming a larger proportion of emerging economies, which are proving to be more resilient to economic shocks. As a result, we see the opportunity set widening. Thinking about how companies and countries deal with the impact of shifting supply chains will be critical, especially in the face of geopolitical uncertainties.

Q: What should investors be mindful of in the times ahead?

Stephen Dover: Over the past decade, investors have been dealing with many secular stagnation challenges and we expect them to continue. It’s important to be aware, that just as rising globalization fuelled growth in emerging and developed markets over the past four decades, this next phase will spark new opportunities. Looking ahead, strong research and analysis capabilities will be key in helping analysts and portfolio managers identify the trends of the next 20 to 30 years, such as which countries (i.e., Mexico) may stand to benefit from the change underway.  

In this uncertain environment, it’s critical to focus on the idea of quality as companies that either improve productivity or have more reliable earnings streams across varied economic environments become more attractive. We believe many high-quality assets with strong profitability and solid balance sheets have been discounted to levels that don’t reflect their underlying resilience. This is where investors will find opportunities in an evolving world.

NOTES:

1. “China’s export growth gains steam despite weakening global demand,” CNBC, August 7, 2022, https://www.cnbc.com.